The govt must find a way to get back on the path to fiscal consolidation while increasing public investment.

The govt must find a way to get back on the path to fiscal consolidation while increasing public investment. (PTI)

The Union finance minister will be presenting the second full-year budget of this government on February 29. In India, the Union budget is not merely an exercise in presenting the annual financial statement which is required to be placed in Parliament under Article112 of the Constitution, but is also an instrument to signal economic policy direction and to initiate reforms. Not surprisingly, the budget presentation is an important event awaited with great expectations from all sections of society. This year, the expectations are greater in view of the pessimistic international economic environment, declining exports and slowing private investment. It is hoped that the budget will provide much-needed signal to revive the investment climate in the country. It is indeed a tight rope walk; the finance minister has to deal with conflicting demands of returning to fiscal consolidation, increasing public investment and moving away from the pro-cyclical fiscal stance. While there will be many initiatives in the budget, here are some essential issues the budget should consider to improve the economic environment in the country.

First, it is extremely important to return to the path of fiscal consolidation. The mid-year review takes the issue of fiscal correction lightly, and I hope the finance minister will not be lured into straying away from the fiscal target. At a time when household sector’s financial saving is just a little over 7% of GDP, irrespective of what RBI does on interest rates, it is impossible for the financial system to lend money to the private investors at low interest rates if the government takes all of the financial savings. With the fiscal deficit of Union and state amounting to 6% of GDP and the UDAY accounting for another 1%, it is not surprising that private sector is unable to secure loans at a reasonable rate of interest. In fact, the cash accounting system hides the real fiscal deficit which is much higher as substantial subsidy payments to Food Corporation of India and fertiliser companies are yet to be disbursed. Furthermore, with interest payments at the Union level accounting for almost 50% of their net tax revenues and 40% of total revenues, any further addition to the debt will only crowd out more productive expenditures. With increase in nominal GDP lower than the real GDP, and with government expenditure having low multipliers, additional fiscal deficit will worsen the debt dynamics. Any further postponement of fiscal correction will seriously erode the credibility of the government.

Second, it is important to increase capital expenditures from the prevailing level of 1.7% of GDP and this has to be done by reprioritising its expenditures and finding additional resources. Indeed, the government has done well this year as it is on course to achieving the budgeted capital expenditure of R2.41 lakh crore which is higher than the revised estimate of the previous year by 25%. This was possible mainly due to compression of subsidies as the price of oil from over $110/barrel to less than $40. Also, the government did well to increase excise duties to mop up additional revenues when the oil prices fell. This bonanza will not continue into the next year and although the oil price has fallen to lower than $30/barrel, fiscal space in terms of lower subsidies and higher excise taxes will not be large.

A number of measures are needed to mop up the revenues required to increase capital expenditures. The most important measure is to divest government’s stakes held in Specified Undertakings of the Unit Trust of India. The total holding is estimated at $7.2 billion, and this serves no social or economic purpose. Divesting this could substantially augment resources needed for public investment. The Fourteenth Finance Commission, too, has made some important recommendations on disinvestment which, if implemented, could substantially raise additional revenues. In addition, the government needs to work on reducing the tax arrears. At the end of FY14, the amount of tax arrears from various taxes amounted to over R5.83 lakh crore or 5.1% of GDP. Almost 86% of this is held up in disputes. In fact, about 47% of the arrears have accumulated in disputes up to 2 years and the arrears held in disputes up to 5 years work up to 76%. The time is opportune to negotiate and settle the disputes and gain some revenue rather than getting embroiled in court cases dragging on for years. With Vijay Kelkar Committee’s report on PPP now available, it should be possible to move ahead on the stuck investment projects and revive the PPPs.

Third, one of the important recommendations of the Fourteenth Finance Commission is to have an independent agency to monitor the implementation of fiscal rules by the government. There are over 35 countries in the world which have such independent institutions. In the United States, the Congressional Budget Office has made important contribution as a watch dog. Similarly, the Office of Budget Responsibility in the UK has played an important role. In many other countries, we have parliamentary budget offices and fiscal councils. The important functions of these institutions are to evaluate the budget forecasts, undertake detailed costing exercises to ascertain the present and future liabilities on public policy pronouncements, and to monitor the implementation of MTFP. Establishment of such an institution will demonstrate government’s seriousness in improving fiscal governance.

Fourth, on the taxes side, the process of phasing out tax preferences will have to be initiated as was promised in the last budget. It is also important to do away with the difference in the tax rate between domestic and foreign companies. The most important is the implementation of the recommendations of the Tax Administration Reform Commission (TARC) which are far-reaching. However, many of the recommendations on the restructuring of the tax department to make it independent and doing away with the post of revenue secretary, important as they are, may not find many takers in the government. On another issue, the government will have to initiate its own measures against Base Erosion and Profit Shifting (BEPS) by multinationals. While multilateral action on this will take some time, the government should not postpone the issue of instituting GAAR any longer.

Finally, on indirect taxes front, major initiatives are necessary to rationalise the structure of excise duty and service tax in keeping with the objective of introducing GST. This entails, increasing the threshold of service tax and reducing that of the excise duty, merging cesses and surcharges with the base rates, pruning the exemption list and reducing the number of tax rates, particularly by pushing the commodities taxed at lower rates to the general rate, and putting the administrative action plan for implementing GST including the transitional measures. This will go a long way to boost the confidence and put greater pressure to have the Bill passed in Parliament.

The author is emeritus professor, NIPFP, non-resident senior fellow of NCAER and member of the executive council, Takshashila Institution